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Agricultural Income under Indian Taxation Laws

INTRODUCTION

Benjamin Franklin, in a letter to Jean-Baptiste, famously wrote that “in this world, nothing can be said to be certain, except death and taxes”. However, there is a head of income that has been free from any kind of taxation under the Income Tax Act, 1961 for a considerable period of time in our recent history, i.e. Agricultural Income. The debate on the taxation of agricultural income has been going on for decades, but no government has ever taken a concrete step in the direction of bringing it under the purview of taxation. Interestingly, contrary to the present scheme of things, agriculture was one of the most heavily taxed activities during British rule in India. The colonial rulers imposed heavy taxes on the farm produces, which often resulted in farmers’ economic ruin. It is one of the reasons why the government of independent India decided to exempt agriculture from the purview of taxation in the country. But in recent times, there have been demands to bring agricultural income into the ambit of tax laws as a growing number of cases have come forward regarding the use of agriculture as a source of tax evasion by non-agriculturists. It is to be noted that there have been both political and administrative reasons for granting exemption to agriculture from taxation, like lack of land records, proof of expenditures, cost of imputed labour etc. Under the Constitution of India, State governments have been given the power to levy a tax on agricultural income via Entry 46 of List II of the Seventh Schedule[1]. After much debate in the constituent assembly, it was decided to confer exclusive power-on state governments to tax agricultural income after taking into account the local conditions. Now, let us understand what exactly is considered as agricultural Income.

Meaning of Agricultural Income

Agricultural income has been defined under section 2 (1A) of the Income Tax Act 1961 and section 10(1) provides that such income is exempted while calculating the total taxable income of an assessee[2]. The Act has provided three components that make up agricultural income.

  • Any rent or revenue derived from land situated in India and used for agricultural purposes[3].
  • Any income derived from land situated in India by agriculture or by performing agricultural operations to make the produce saleable[4].
  • Any income derived from a building used for agricultural operations provided that the building is in the vicinity of the land and is being used as a dwelling house, as a storehouse, or other out-building by the cultivator (landlord or tenant)[5].

On a plain reading of the section, few questions would arise. What is an income derived from land? What are agricultural operations? What is considered an agricultural purpose? While the act does not define these terms, over the years, the courts have given meaning to them through various landmark judgements. In Bacha F. Guzdar v. C.I.T., Bombay[6], the Supreme Court interpreted the meaning of “income derived from the land”. The court refused to extend the scope of the term beyond its legitimate limits. Gulam Hasan, J observed that “Agricultural income as defined in the Act is obviously intended to refer to the revenue received by direct association with the land which is used for agricultural purposes and not by indirectly extending it to cases where that revenue or part thereof changes hands either by way of distribution of dividends or otherwise”. Hence, to be considered “derived from land”, there has to be a direct connection between the land and the income. Moreover, the receiver of such income should also have a direct relationship with the land to avail the benefit of the exemption granted to agricultural income. One of the most prominent judgements in the area of agricultural income was pronounced in C.I.T. v. Benoy Kumar Sahas Roy[7]. In this case, the court delved deeper into what constitutes agriculture and agricultural income. The court adopted a wider definition of agriculture and observed that “We have, therefore, to consider when it can be said that the land is used for agricultural purposes or agricultural operations are performed on it. Agriculture is the basic idea underlying the expression ‘agricultural purposes’ and ‘agricultural operations’, and it is pertinent, therefore, to enquire what is the connotation of the term ‘agriculture.’ As we have noted above, the primary sense in which the term agriculture is understood is agar-field and cultra- cultivation, i.e., the cultivation of the field and the term is understood only in that sense, agriculture would be restricted only to the cultivation of the land in the strict sense of the term meaning thereby, tilling of the land, sowing of the seeds, planting and similar operations on the land. They would be the basic operations and would require the expenditure of human skill and labour upon the land itself. There are, however, other operations which have got to be resorted to by the agriculturist and which are absolutely necessary for the purpose of effectively raising the produce from the land”.

Hence, the court created a distinction between “basic operations” and “subsequent operations” that are performed after the sprouting of produce. The court held that subsequent operations can be considered agricultural operations only when they are integrated with basic operations and are seen in conjunction with one another. These integrated activities together constitute agriculture, and the land on which these operations are performed can be considered as used for agricultural purposes.

Sale of Agricultural Land

It is important to note that agricultural land was not considered a capital asset before 1970, and as such, proceeds from the sale of agricultural land were considered as agricultural income and were exempted from taxation. The government, then, brought in the Taxation Laws (Amendment) Act 1970 inserted section 54B to the Income Tax Act 1961[8] and changed the ambit of “capital gains”. The amendment changed the nature of agricultural land situated in urban areas into a capital asset and imposed a tax on the sale of such land under certain circumstances.

Income is partially agricultural and partially non-agricultural

In exercise of its regulatory power under the Income Tax Act, the government has formulated certain rules to be followed for better implementation of the Act. These rules are called Income Tax Rules, 1962. Rule 7, 7A, 7B and 8 of the Income Tax Rules govern such income which consists of agricultural as well as non-agricultural income.

Rule 7 deals with income which is “partially agricultural and partially from business”. The rule provides that in the case of income which is partially agriculture and partially chargeable under the head “Profits & gains of business”, the market value of the agricultural produce raised or rent-in-kind received by the assesse shall be deducted to determine the chargeable income[9].

Rule 7A provides that income from the manufacture of rubber be considered as income derived from business and 35% of such income shall be liable to be taxed as such[10] while rule 7B states that 25% of the income derived from the sale of coffee grown and cured by the seller in India shall be taxable as business income. However, if the coffee is grown, cured, roasted and grounded with or without chicory or any other flavourings ingredients then 40% of the income shall be taxable[11].

Rule 8 governs the tax liability of income from the manufacture of tea. It provides that 40% of the income derived from tea grown and manufactured in India shall be liable to tax as business income[12]

Unintended consequences and the road ahead

The exemption granted to agricultural income from taxation with the benign purpose of providing relief to the farmers from years of exploitation by the colonial rulers has produced some unintended consequences. Today, the exemption is being misused by large farmers and agricultural companies and the agriculture sector is being used as a tax shelter. In the assessment year 2020-21, more than 21 lakh taxpayers claimed exemption granted to agricultural income, out of which nearly 60,000 reported an income exceeding Rs. 10 lakh. A parliamentary panel has recommended better scrutiny of such high agricultural income to plug evasion of taxes[13]. Income thresholds in agricultural income can be introduced for taxation purposes to protect small farmers and to prevent evasion of taxes by big farmers and non-agriculturists or a tax based on the size of landholding can be introduced to stop the leakage of tax revenue as even today a vast majority of the farmers own less than 2 hectares of land. Moreover, better administration of current laws can also help in curbing the evasion of tax. The CAG report published in 2019 revealed that exemption was granted in 22.5% of cases without adequate documentation or verification, and proof of agricultural income like bills and invoices was absent in 18.7% of cases[14]. These problems can be avoided by updating and proper implementation of rules of compliance. There has been a push for the formalisation of the economy by the government to provide benefit to society at large. Hence, it is time that the exemption given to agriculture in taxation is scrutinised and an effective mechanism is put in place to prevent tax evasion and enlarge the tax base of the country.

Author(s) Name: Abhishek Dagar (University of Delhi (Law Centre II))

References:

[1] Constitution of India, Seventh Schedule < https://www.mea.gov.in/Images/pdf1/S7.pdf> accessed on 25 May 26, 2022

[2] The Indian Income Tax Act 1961

[3] The Indian Income Tax Act 1961, s 2(1A)a

[4] The Indian Income Tax Act 1961, s 2(1A)b

[5] The Indian Income Tax Act 1961, s 2(1A)c

[6] Bacha F. Guzdar v. C.I.T., Bombay, AIR 1955 SC 74

[7] C.I.T. v. Benoy Kumar Sahas Roy,  AIR 1957 SC 768.

[8] The Indian Income Tax Act 1961, s 54B

[9] Income Tax Rules, 1962, rule 7

[10] Income Tax Rules, 1962, rule 7A

[11] Income Tax Rules, 1962, rule 7B

[12] Income Tax Rules, 1962, rule 8

[13] Rahul Shrivastav ‘Income Tax return: Parliamentary panel pushes for strict assessment of agricultural incomes’ Indiatoday.in (6 april 2022) <https://www.indiatoday.in/business/story/income-tax-return-parliamentary-panel-pushes-for-strict-assessment-of-agricultural-incomes-1934237-2022-04-06> accessed on 26 May 2022

[14] https://cag.gov.in/cag_old/sites/default/files/audit_report_files/Chapter_5_Assessments_relating_to_Agricultural_Income_of_Report_No_9_of_2019_Compliance_Audit_of_Union_Government_Department_of_Revenue_Direct_Taxes.pdf